Michael Hicks: Low unemployment is time to rethink our economic development policies

Indiana’s unemployment rate has hit a "once in a generation" low point that is well beneath the level considered normal for a healthy economy. This is an especially good time for workers, who should be anticipating wage and salary increases. At the same time, our labor force growth has slipped into negative territory over the past few months.

While this is widely thought of as a warning sign, I don’t think that is the case. Indiana’s labor force grew far more aggressively than the nation in the years after the Great Recession, so it is not surprising that we face slow labor force growth. However, these data should occasion a period of serious and sustained reflection about local economic development strategy. Here’s why.

For almost half a century, economic development policy in Indiana has been about attracting new employers. Statewide, we spend well over $1 billion per year on attraction through tax abatements, tax incentives, direct infrastructure spending, workforce training, marketing and myriad other enticements to business. Moreover, if Indiana demanded local governments adhere to national accounting standards, we would likely discover that we spend closer to $2 billion annually on attracting businesses to the state. That amount is equivalent to roughly one-third of our total education budget, so it may be the least discussed major funding issue in the state.

The most important single assumption supporting all our economic development efforts is that labor supply is perfectly elastic. This means that for every new job attracted to the state, there is a ready and willing worker. That key assumption is wholly wrong. In fact, the value of labor elasticity is not infinite, it is effectively zero, and has been close to zero for decades.

Now, I do not mean to suggest that our economic developers actually make this calculation. I don’t even think that economic developers or their boards even really understand how this assumption matters or what it means for choosing the right policies for their communities. That is a separate problem.

Of course, economic developers, their boards and the vast consultant community will argue that they do worry about whether there are enough employees for a relocating firm. They do of course; not least because that is the first question a new firm will ask of a community. Indeed, most local economic development groups even fund studies that count the number of workers that can be lured away from local businesses. I’ve always thought this a puzzling approach to member relations. Still, this simply reveals how little economic knowledge actually bleeds into the discussion about local economic development. When the labor supply elasticity is low, a new firm relocating to Indiana will not create new jobs but will simply cannibalize workers from other firms in the region.

Now in a world of open competition, we should welcome new better job offers for our citizens. However, that is not what is happening in Indiana. Local economic development policy in Indiana creates a vast array of incentives that mostly target new employers. These new, heavily subsidized firms hire new workers, but they do so by luring employees from existing firms. Across the state, economic developers are not really helping create new jobs. What they do instead is subsidize the movement of workers from existing firms, who pay state and local taxes, to new firms whose tax liability is vastly reduced by incentives. Taxpayers, especially local businesses, should be outraged at these efforts.

Not only does the current model of economic development disadvantage existing firms, it also tends to reduce that all important labor supply elasticity. You see, these business relocation policies lead to significantly fewer local tax dollars through incentives. That means less money to pave roads, modernize schools and refurbish aging infrastructure. This shifting of resources to economic development actually makes our communities less enticing, thus reducing the supply of available workers.

Today, Indiana’s local economic development policies are not merely ineffective; they are counterproductive. I think most elected officials know this but are trapped by a chorus of economic development officials and well-meaning but uninformed voters demanding "jobs, jobs, jobs." Well, we now have all the jobs we could possibly want and, by some accounts, more than we can fill. This is the time to change direction.